Pension Contributions: Personal or Company

Pension contributions are very tax effective - but should these be paid from personal income or directly by your company?

Pension Contributions: Personal or Company

If you pay a pension contribution through your limited company, this is similar to paying yourself a bonus except that you won't be able to get your hands on the money straight away.

So what are the tax savings if you make pension contributions personally?

​Let's illustrate this with the following example:

Kirk owns Enterprise Ltd. He has taken a salary of £8,424 and dividends of £37,926 to take his income up to the basic rate band of £46,350 leaving him with net income of £43,912 after tax (for more details refer to our blog here). The company still has £15,000 of post tax profits left in the company bank account.

If Kirk wants to use the money to make a pension contribution he has the following options:

  • Pay a dividend and make a pension contribution personally
  • Make a pension contribution from the company

If Kirk takes the remaining £15,000 as a dividend he will pay 32.5% income tax (£4,875) leaving him with net income from the £15,000 dividend of £10,125.   This means his total income after tax will be £54,037 (£43,912 noted above plus £10,125).

However it is important to note that any pension contributions in excess of £3,600 that are paid personally cannot exceed your earnings.  Salary is treated as earnings, whereas dividends are not.

Therefore because Kirk's earnings are £8,424 (see above) the maximum gross pension contribution he can make personally is £8,424. So Kirk invests £6,739.20 of his own cash to his personal pension plan.  HM Revenue then add £1,684.80 in basic rate tax relief (£8,424*20%) for a total gross contribution of £8,424.

Additionally when Kirk submits his 2019 personal tax return to HM Revenue, he will receive £2,106 of higher rate tax relief which is calculated as £8,424 x 25% (32.5% less 7.5%).

In total Kirk will save £3,790.80 in making a personal pension contribution: 45% of his gross contribution of £8,424.  (This saving is higher than usual because Kirk has dividends - if Kirk only had earned income it wouldn't be as high.  Most higher rate taxpayers only receive 40% tax relief on their pension contributions so this is a very beneficial outcome for Kirk).

However the downside of making this personal pension contribution is that Kirk's after tax disposable income has fallen from £54,038 to £49,404.80 (£54,038 less pension contribution of £6,739.20 plus the higher rate tax relief of £2,106). 

So although in tax terms Kirk is better off, he has less money to spend during the tax year 2018/19 and will have to wait until he is 55 to access any of the funds he has invested as pension contributions.

What if the pension contributions are paid directly by the company?

If pension contributions are made by the company then these will not be restricted to Kirk's earnings of £8,424 (see above).  However we'll assume Enterprise Ltd invest the same amount on Kirk's behalf.

Whilst Kirk doesn't receive any tax relief personally, Enterprise Ltd can claim the amount of the pension contributions as a deduction against its taxable profits.

In order to demonstrate how a pension contribution made by the company will effect Kirk's financial position we'll need to look at the position for both the company and Kirk.

Enterprise Ltd:

Original position:

Profits

Less: Corporation tax

Profit after tax

Less: Dividend taken

Retained profits

Effect of additional pension contribution:

Less: Pension contributions

Plus: Corporation tax saving at 19%

Retained Profits

Kirk:

Original position:

Post tax profits taken as a dividend

Income tax

Effect of additional pension contribution:

Post tax profits taken as a dividend

Income tax at 32.5%

Dividend received after tax



£65,340

£12,414

£52,926

£37,926

£15,000


£  8,424

£1,600

£8,176



£37,926

£2,438


£8,176

£2,657

£5,519

As Kirk's total after tax income is £49,431, (£43,912 plus £5,519) instead of £49,404 (£43,912 plus £5,492), the pension contribution made by the company is slightly more tax effecient than the pension contribution paid by Kirk personally from the £15,000 dividend.

What if Kirk wants to make pension contributions in excess of £8,424?

Basically Kirk has two choices

  • Pay himself more salary
  • Get Enterprise Ltd to make an additional contribution

Paying a salary is not tax effective because the additional salary will attract employees and employers National Insurance of 12% and 13.8% repectively. These liabilities can't be avoided as pension contributions only attract income tax relief.

It therefore makes sense for the company to make a contribution.

The good news is that you don't need a dedicated company pension scheme for the company to make a contribution. Most personal pension providers have special forms that allow the company to make contributions.

How much can the company contribute?

Whilst the company contribution is not limited to your salary of £8,424 above, it may be capped by the annual allowance of £40,000 which is the combined maximum that can be paid by you and the company. 

You'll need to ensure that any company pension contribution is commercially viable and in line with your remuneration package.

However on the basis that you pay yourself a small salary and pay the rest as dividends you should have plenty of justification for the company to pay a larger pension contribution, though remember this will be subject to the pension annual allowance of £40,000 referred to above.

Our eBooks cover this and many other topics.  Check them out here.

And if you'd like to know how we can help you with all of this, or with anything else, feel free to give us a call on 01202 048696 or email us at richard@tfaaccountants.co.uk.

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